Over the last decade, observation care-a hospital-based outpatient service used to evaluate and treat acutely ill patients for extended periods-has become an increasingly common, but controversial, alternative to full hospitalization affecting more than 1 million Medicare beneficiaries annually (National Center for Health Statistics 2010; Feng et al. 2012). Proponents argue that observation care represents an alternative to short- stay hospitalization (< 48 hours) and a net cost savings to the health system, while critics argue that observation care shifts the cost burden of expensive inpatient care onto patients, and may compromise the quality of care (Baugh et al. 2011; Ross and Bellamy 2010). There is also significant variation in observation care use-including racial and geographic disparities-and it is unclear both what drives these disparities and whether observation care results in better or worse patient-centered outcomes than short-stay hospitalizations (Feng et al. 2012). Thus, the overall objective of this study is to understand the causes of racial and geographic disparities in the use of observation care among Medicare fee-for-service beneficiaries and the implications of these disparities for patient-centered outcomes. In pursuit of this objective, the proposed study has the following specific aims: 1) To determine the extent to which disparities in observation care are driven by patient and hospital level factors; and 2) To assess the association between observation care and patient- centered outcomes by race and rurality. To achieve these aims, four years of Medicare inpatient and outpatient claims and enrollment data (2007-2010) will be used to model observation stay rates as a function of variation in patient race and rurality within and between hospitals. Then, the 30- and 90-day ED visit, hospital readmission, and mortality rates of patients placed in observation care versus those placed in short-stay admission (d 48 hours) will be evaluated, controlling for a variety of factors including patient comorbidities. Heterogeneity in the impact of observation on outcomes by race and rurality will also be evaluated. The proposed research is significant because it will indicate whether disparities in health outcomes could potentially be reduced by policies that address disparities in observation care use, and whether policy strategies to reduce disparities in the use of observation care should be targeted towards individuals, system-level factors, or both. The proposed research is innovative because it uses comprehensive national person-level Medicare claims data to investigate racial and geographic disparities in the use of observation care to identify both its upstream and downstream consequences, and will assess for the first time the impact of the decision to admit or observe on health outcomes. This study is expected to have an immediate positive impact on Centers for Medicare and Medicaid Services (CMS) policymakers, payers, providers, and hospitals as they develop policies on the appropriate use of observation care. As these policies are implemented by CMS and other payers to improve the quality of care and reduce disparities, patients will be the ultimate beneficiaries of this researc.